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9
POLICY • Vol. 30 No. 3 • Spring 2014
Pedro Schwartz
agreement; that the resulting agreements were not
determined by government or in court adjudication
of the right to pollute or to be indemni ed;
and that solutions imposed by government
often resulted in worse outcomes than the
starting situation.
George Stigler in his Memoirs (1988) tells the
story of the famous 1960 dinner at the home of
Aaron Director to discuss 'how so ne an economist
as Coase cold make so obvious a mistake’ as
to criticise Pigou’s theory. Twenty economists,
among them Milton Friedman and George Stigler
himself, listened to Coase making the heretical
proposition that
Whatever the assignment of legal liability
for damages, or whatever the assignment of
legal rights of ownership, the assignments
would have no efect upon the way
economic resources would be used!
In the end Coase changed a minority of one
at the beginning of the dinner into unanimity of
21 in his favor.
Coase did not take it for granted that markets
functioned perfectly. High transaction costs often
made it difcult to come to efective agreements.
But he pointed at the often unrecognised
government imperfections and at the nugatory
efect of sovereign decisions, and concluded that,
when markets did not function and there was
high probability of government failure, then doing
nothing could turn out to be the best policy.
Stigler recast these thoughts of Coase's into
a theorem by boiling down Coase's theory into a
simple model. When remembering the dinner, he
said that Coase had asked them to assume zero
transaction costs. ough the assumption was
heroic in most cases---because transaction costs are
never zero in a market—once accepted, the fnal
agreement could be expected to be an optimum.
To explain this, Stigler did give a real example of
zero transaction costs: if both the polluter (the
cattle owner) and the party harmed (cultivating
corn in an open eld) merged into a single rm.
In that case the single owner would organise
production so as to maximise the joint product
of both activities. Tat is what in his Memoirs he
called ‘the Coase Teorem’. No formal Coase
theorem can be found in Coase’s work.
If Coase made the assumption of zero transaction
costs at the dinner, it must have been because that
was the way his Chicago friends tended to reason.
But in the seminal 1959 paper on the Federal
Communications Commission where he proposed
that radio frequencies be auctioned to the highest
bidder and rejected administrative allocation
of frequencies, there was no mention of zero
transaction costs. And neither is there in Coase and
Wang’s book on China’s road to capitalism.
Cooter on Coase
One of the most efective critics of Coase on social
cost is Robert Cooter in his 1982 article ‘Te
cost of Coase’. He there shows that, from the
point of view of ‘objective’ or ‘outside evaluation
of ’ efciency, Coase’s theorem is only valid
under conditions of perfect or at least sufcient
competition.
Te reason why this is so is that the distributive
efects of moves to make markets more efcient
will give rise to disputes about the sharing of the
benefts and therefore to indecisive bargaining.
A fully competitive market is a pure cooperation
game, where the distribution of gains from moving
nearer to a Pareto optimum are nugatory or nil,
since participants cannot threaten each other
with strategic moves. When numbers are small
there always is the danger that the attempt of one
party to hog most of the bene t of the proposed
move will lead to a breakdown of negotiations
and losses all round. e way out from these
mutually destructive attitudes is said to be one
of two: Coasians will propose that transactions
barriers be removed so that the bargaining takes
place in as fully competitive a situation as possible;
Hobbesians on the contrary will want to create a
Leviathan with powers to contain the violence
of participants.
Cooter is quite right in saying that a number
of elements in bargaining processes are wrongly
classifed under the rubric of transaction costs:
Coase did not take it for granted that markets
functioned perfectly.